Year-End Captive Advice

There continues to be a large swell of interest in and
applications for tax advantaged structures. This year, 2012,
presents the possibility of being the final year of several
significant tax positions, and advisers are rushing to complete
new captives while the gates are open.

As these captives are being formed, it behooves the alert
captive prospective owner to be reminded of some issues that may
well draw your captive into unwanted scrutiny.

Actuarial Feasibility Study

The first issue perhaps is the necessity of an actuarial
feasibility study to accompany the application. I have
encountered advisers who believe that this step is satisfied by
the domicile's own actuarial review of the captive applicant's
actuarial report. These are not
the same thing. One will not satisfy the requirement of the
other. By not getting your own actuarial study, you will delay
the application for many weeks, probably missing the tax
opportunity.

Having an actuarial feasibility study not only satisfies the
regulators that an independent outsider has analyzed the
numbers, but it also gives comfort to the captive's
owners/investors/directors that there is an outside professional
view available. The domicile's actuarial review is a simpler
review done by another firm to assure the regulator of the
reasonableness of the captive's assumptions. They are two very
different reviews indeed.

831(b) Tax Exception

Another issue is the ever-present challenge of the 831(b) tax
exception. Doubtless, many applications being considered are
planning to take advantage of the 831(b) exception. Enough has
been said about these, but be reminded that there is heightened
interest in this exception by the Internal Revenue Service. In
addition to the scrutiny of the actuarial study is the increased
interest in the risk pools. In order to be in compliance with
the 831(b) exception, the captive must reinsure 50 percent plus
or minus of its premiums. This is often done by the promoters'
own offshore entity. That's okay. But if there are no claims in
the pool, its legitimacy as an insurance company, and thus the
legitimacy of the deduction, are in question.

As a captive owner, you may not be concerned about the
ownership goals of the risk pool; you should be. The owner may
well not wish to pay claims, even with your money, thus
jeopardizing your own captive.

New Domicile Options

For those owners/advisers not seeking the 831(b) exception,
now is the time to also pay close attention to the ever-shifting
domicile landscape. We recently have seen the highly promoted
openings of Connecticut, Oregon, Florida, and perhaps Ohio as
new captive domiciles. There will be more. They will each
promote their advantages in terms of taxes—or lack thereof—and
the efficiency of their processes. This may well be true, but at
bottom is the motivation of their ability to tax captives whose
insureds are domiciled within the captive domicile. This is the
result of the Nonadmitted and Reinsurance Reform Act portion of
the Dodd-Frank Act.

The tax motivation may well override the new domicile's
ability to provide comprehensive legislation and knowledgeable
regulators. In fact, a close reading of the actual legislation
of some of the newest domiciles raises the suspicion that the
language was provided by promoters with very specific goals.
These goals, not known to you, may not be in accord with your
goals.

Much has been written and spoken about the paucity of
qualified regulators; starting new domiciles won't address that
problem. Nothing would more benefit the industry than to grow
more regulators with thorough and useful knowledge of captives.
If you are considering an application to a new domicile, closely
review not only the laws and regulations but also the resumes of
the regulators. As they will wish to interview you, remember
that it should be a two-way interview. How will they work to
help you make your captive successful?

Independent Directors

And finally, it is important to note the rise in the use of
outside, independent directors. To some, this may seem a
contradictory position in a closely held captive, but the
requirements and vagaries of today's world are calling for more,
not less, outside review. Each new captive being formed should
consider the use of one or two independent outside directors. If
well chosen, they can provide an independent view, additional
knowledge and experience, and assurance to regulators and other
outsiders. An ounce of prevention is indeed worth a pound of
cure.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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